Question

5. The Running for Life Centre is considering replacing its treadmills and is faced
with a choice between two models: the Track model costing £800 per
machine and the Pro model costing £1,400 per machine. The Pro model is
sturdier and the cost of maintenance per machine is £50 per year. The Track
model is less robust and requires more maintenance costing £75 per machine
per year. The Track model is also less durable. The Running for Life Centre
estimates that it would need to replace the Track machines after 3 years of
use and that it would need to buy 30 machines to ensure that enough are
working at any particular time. The Pro model would last 4 years and only 25
machines would be needed. All other revenue and costs for the Running for
Life Centre would remain the same. The required discount rate for this project
is 10%.

Required:
a) On the basis of the information provided, which machine should the Running
for Life Centre buy? Explain.

[15 marks]
b) What other information would you consider before taking a decision?
[5 marks]
[Total 20 Marks]

Answer 1

a]	As the two models have different lives the analysis has to be based on annual
	equivalent worth cost. The workings are done below:
	TRACK MODEL:
	Total cost of the machines = -800*30 =	$             24,000
	AW of the total cost = 24000*0.10*1.1^3/(1.1^3-1) =		$            (9,651)
	Annual maintenance cost = -75*30 =		$            (2,250)
	AW of the cost of owning and maintaining		$ (11,901)
	PRO MODEL:
	Total cost of the machines = -1400*25 =	$           (35,000)
	AW of the total cost = -35000*0.10*1.1^4/(1.1^4-1) =		$ (11,041)
	Annual maintenance cost = -50*25 =		$ (1,250)
	AW of the cost of owning and maintaining		$ (12,291)
	As the AW cost of the Track Model is lower, it should be bought.
b]	Other information to be considered:
	*Any training required for the operating staff for the new equipment.
	*Comparative efficiency in performance of the machines